Key Terms Explained
Financial Depth (Size)
The financial structure of a country is the mixture of banks, non-bank financial institutions (NBFIs), and the financial markets in the system. Financial depth or deepening can be regarded as the measure of the size of financial institutions and financial markets in a country.1 Well‐developed financial systems are deep, i.e. sizeable relative to the overall size of the economy. It provides the economy with credit and other financial services.
Financial depth is correlated with long‐term economic growth and poverty reduction.2 For example, the annual average value of private credit across countries was 39 percent with a standard deviation of 36 percent. Averaging over 1980–2010, private credit of financial institutions was less than 10 percent of GDP in Angola, Cambodia, and Yemen, while exceeding 85 percent of GDP in Austria, China, and the United Kingdom. For financial markets, research has shown that the trading of ownership claims on firms in an economy is closely tied to the rate of economic development. For instance, the mean value of stock value traded is about 29 percent of GDP. In Armenia, Tanzania, and Uruguay, stock value traded annually averaged less than 0.23% over the 1980‐2008 sample (10th percentile). In contrast, stock value traded averaged over 75 percent in China (both Mainland and Hong Kong SAR), Saudi Arabia, Switzerland, and the Unites States (90th percentile).3
Many proxies have been used to measure financial depth. For financial institutions, the most common variables being used in today’s literature are private credit as a percentage of GDP and total banking assets to GDP. Private credit is defined as deposit money bank credit to the private sector, while total banking assets include credit to government and bank assets other than private credit. Aside from these two bank-related measures of financial depths, there are a few non-bank financial institutions (NBFIs) proxies such as total assets of NBFIs to GDP, which includes pension fund assets to GDP, mutual fund assets to GDP, insurance company assets to GDP, insurance premiums (life) to GDP, and insurance premiums (non‐life) to GDP.4
For financial markets, the most common proxies to measure the size of stock markets and bond markets ( two main segments of the financial market) is stock market capitalization to GDP and outstanding volume of debt securities (private and public) to GDP respectively. Other market development indicators include stock market transactions as a share of GDP. 5 Stock market capitalization measures the value of listed shares on a country’s stock exchanges as a share of GDP, while stock market transactions indicator incorporates information on the size and activity of the stock market, not only the value of listed shares.
The ratio of the depth indicators for banks and financial markets, called financial structure ratio, can be used to approximate the relative mixture of financial institutions and financial markets in a system. The degree to which the financial system is relatively ‘bank‐based’ or market‐based’ plays a role, as literature has shown that services provided by financial markets tend to become relatively more important than those provided by banks as a country develops. 6